Thoughts from the Summit on Economic and Financial Literacy

I’ve been out of the office the past couple days. Yesterday I was at a professional development program, but the day before I was in Washington, D.C. attending the Third National Summit on Economic and Financial Literacy. The program focused on the results of the Economic Report Card from the National Assessment of Educational Progress released this past summer. The Summit itself was a meeting of concerned organizations (public and private, for profit and charitable) that are concerned with the state of economic and financial literacy in the United States.

There were a wide variety of speakers, and although they were preaching to the choir; many of them left the audience with audience with a lot to speak about, even when speaking what should be obvious. They gave me a lot of material for this blog. I’m not yet sure I’ll use it all, but here are some of the thoughts I walked away with.

The welcoming remarks were by Robert Duvall (not the actor), President and CEO of the National Council on Economic Education. He was followed by Andrew Plepler, President of the Bank of America Charitable Foundation. In his opening remarks, Plepler spoke about current economic conditions and the relation to economic and financial illiteracy. He spoke about the fact that a great many people made a great many errors – in taking out loans, in making loans, and in overseeing the lenders and loan originators. But it was a following comment that spoke the loudest. He said something to the effect of “This is not government’s problem to fix.”

I thought about this, and listened to the rest of his remarks. The meaning I took from his comment was that the decisions that had been made, and the resources that had been loaned, and promised for repayment, were in the realm of voluntary private transactions. Many of them were ill-advised, to be sure. But it was from the same private sector that the best remedy could come. Financial institutions needed to work with borrowers to reschedule, refinance, and refigure how best to keep people in their homes, and keep the loans active. Borrowers needed to look at the loan from the perspective of saving their homes. Neither party should be looking at the situation from a purely balance sheet perspective of asset value vs. liability.

It would be by working together to resolve the problem that all parties would learn the most from it. Expecting an outside agency to rescue both borrower and lender does not teach us anything other than someone will bail out mistakes. Rather, as educators, businesspeople, and bureaucrats concerned with economic and financial literacy, we need to improve economic and financial education so that people in similar situations in the future do not make the same mistakes.

If I understood him correctly, I would have to agree. And I would add one more thing. Economic and financial literacy should include an understanding of the institutions and laws that guide our participation in the marketplace. Too often, those institutions, which include trust, property rights, and redress, are not given enough visibility when we teach. Like many other people, I am impressed by the amount (both numbers and dollars) of transactions that take place on trust in this economy. Events like those of the past few months have the potential to shake that trust. Those who deliberately used deception when they entered the market should face a price above any losses they may be facing. For trust is an institution that we can't afford to lose.

I look forward to your thoughts.

What I'm Reading

I just finished a book that, despite some cosmetic issues, is a good resource for any economics or personal finance teacher to have on the shelf. And for those of you teaching a course on the global economy or current events, you might want to use it as an optional or auxiliary text. The book, Globalization, is by Don Boudreaux, Chairman of the Economics Department at George Mason University. If you read the Cafe Hayek blog, you're already familiar with his writing style; and if you follow the "Letters to the Editor" section of any of a number of major newspapers, you're familiar with his name.

Boudreaux does a very good job of taking what is a highly emotional subject for many, and dissecting it in a very entertaining and informative manner. The fact that the book is only eight chapters and 162 pages long (including glossary and index), and you have a simple, enjoyable book on a topic of high current interest.

My only complaints with the book have to do with the editing. In chapter two, there are a couple of bubble charts that could have been better rendered in color (if the idea was to be able to differentiate regions or countries), or had some other ways of providing detail. The charts should have provided "information at a glance." But in my case, they were of little help. And two figures in Chapter 7 appear to have the titles reversed. It was easy enough to figure out which needed to be which, but this should have been caught before going to press.

Nevertheless those errors do not detract from the overall value of the book. I would hope you would consider checking it out of a library at the very least, or buying it for your own use. I don't think you'll regret it.

I look forward to your comments about the book.

Movies and Economics

A few days ago, an item on the Real Time Economics blog caught my eye. The Federal Reserve Bank of Dallas runs has an annual essay contest for high school students in the 11th District. This year they're asking students to identify economic concepts in the movies. Read through the comments to this post. Some of them insightful, some of them revealing (a few have nothing to do with the topic and are anti-Federal Reserve rants).

Then, I ran across an interesting graphic in the interactive edition of The New York Times. It presented movie revenues in an innovative and interesting way. But that and the fact that the Academy Awards were this past weekend, reminded me of another economics lesson.

A former colleague of mine, who was an outstanding AP Economics teacher in the south suburbs of Chicago, had some students who applied the lessons of price inflation to movie box office. This was back in 2001 so the information has changed. But they went on-line, found the top 50 grossing movies (not gross movies) of all time and then applied a GDP (Gross Domestic Product) deflator (link no longer operative) to account for inflation and see which movie really was the top when measured in constant dollars. (Please note, official data only goes back to 1947 so years prior to that were estimated.)

I have the file given to me in 2001. If anyone's interested, I will gladly provide it. If anyone is interested in updating and sharing here, please...

share your comments.

An Interesting Insight

I have to thank fellow blogger Bill Polley for this link. Joseph Sternberg of The Asian Wall Street Journal wrote an interesting column for the De Gustibus section of The Wall Street Journal. He shared his tendency to avoid carrying change and how, in Hong Kong, he found himself with a sizeable pile of coinage. Not having access to the change counting machines found in many U.S. grocery stores, he took his change to his bank. They were perplexed at first, but rose to the occasion. After counting the coins they deposited the proceeds to his account and returned him one U.S. cent.

The piece brought back memories for me. When I was at my former position with the Federal Reserve Bank of Chicago, I was told by someone that the Seventh District was the largest user of coin in the Federal Reserve System. I don't know if this is still the case, but I would often share this trivia with teachers and tour groups, giving them an opportunity to speculate on the reason.

People from the greater Chicago metro area often cited toll roads. I would then remind them that Chicago was not representative of the rest of the district - and had a lot more toll roads than other parts of the five-state area. Other reasons were related to the transit system and casinos. I then told them that I was told one reason was the penchant of Midwesterners to hoard coins rather than circulate them. And while I'm sure other folks in other parts of the country (and the world, apparently) share this same habit, Midwesterners do it as well as any and maybe better.

I often recounted the tale of the penny shortage in the late 1990s. There was a news story about a gentleman in Indianapolis who bought a brand-new, all-the-options pickup truck. Paid cash -- all pennies. The news story reported the cost of the truck was in excess of $25,000. You do the math. Now that's keeping the change. (The opportunity cost in lost interest must have been significant. And maybe liquidity preference is a factor.)

Anyone else have good stories to share about change hoarding?

The Credit Crunch and the Business Cycle

The current credit crunch has brought renewed interest in the business cycle for economics and personal finance classes - at least I hope it has. And although the political candidates are going out of their way to let us know how they will remedy the business cycle, few are willing to explain how the business cycle impacts credit.

This brings me to an interesting article (subscriber content) on the front page of today's edition of The Wall Street Journal. The article is titled "Lending Squeeze Hits Ailing Firms." The article mentions that a number of firms, some of which are already under bankruptcy protection, are finding it harder and harder to borrow funds. This can mean that interest rates are inordinately high, or that credit is not available at all. And to understand this, we need to examine the components of an interest rate.

Interest rates are, of course, the price of money. But that price incorporates a number of risks for the lender. First of all, lenders seek a return on the funds to offset the opportunity cost of lending (they could have been spending the funds elsewhere but chose to postpone consumption). There are several risks at work here. First, is maturity risk - how long will it take for repayment. Generally, a loan with longer maturity represents higher risk, and will generate a higher interest rate. Inflation expectations usually figure in here, as well. Second is liquidity risk, how easy will it be to convert the loan to cash. Some items, like homes and businesses are not very liquid, as we've seen. Therefore they may entail a higher risk and a higher rate. And finally, there is default risk. What is the likelihood that this loan may not be repaid. A firm that is in questionable financial shape to begin with may not be able to pay off additional loans. In that case, the default risk is considered high and again, carrying a higher interest rate on a loan.

Many of the firms in the story are already in financial trouble. The current business cycle will make it more difficult for these firms to generate revenues to pay off debt. Consequently, the interest rates are high when credit is even available. This brings us to the business cycle.

One of the basic aspects of any downturn in business is that less efficient, less productive, less profitable firms are shaken out. This frees up resources, in this case capital resources, to be shifted to other areas of economic activity that are more efficient, more productive, and more profitable as determined by consumer demand. Does this mean that the process is painless? No. Does it mean it should be avoided? No. And an economic downturn provides information to all players as to which areas need to be adjusted.

Have you been using the current situation to discuss the business cycle and the related credit crunch? If so, please share your thoughts and your students' comments. If not, please share why you feel it may not fit into your curriculum.

More on Distribution

The ongoing discussion about income/wealth/spending disparity has been the subject of several recent posts to this blog. But that conversation exists largely because of a debate about the nature of the "middle-class" in the U.S. Some hold that's shrinking, others contend that it's not shrinking but dynamic because people are constantly moving in and out of it. And who moves and which direction frequently boils down to whether you're measuring income, wealth or spending. (I won't go into the logic of how moving everyone up only shifts the middle without eliminating the bottom.)

But it begs a more fundamental question, "What is middle class?" And while I wouldn't pretend to have the answer to that, it's still interesting.

An article in a recent issue of The Economist magazine focused on The In-Betweeners (premium content) - the middle class in emerging economies. The idea is particularly interesting because, if we really want to eliminate poverty, what we are aiming for is moving more of the people in the lowest economic group into a higher group. The article highlights a paper by two MIT economists that provides some interesting insights. It examines common and disparate characteristics of the middle class in various economies around the world. And it is perhaps as interesting in defining the view of what constitutes "middle class" in this country as it is about defining that term for other parts of the developing world.

While I've only read the article, I have skimmed the paper. I intend to read it all because it was very readable and very interesting. I recommend it if only to help provide students in economics and personal finance courses a sense of relativity and an understanding of how we differ as well as how we're the same. After all, according to Globalization 101.org, "This process has effects on the environment, on culture, on political systems, on economic development and prosperity, and on human physical well-being in societies around the world." It seems to me the better we understand each other, the more we have to gain, economically and culturally, from the process.

I look forward to your comments.

Stimulus and Wealth/Income/Consumption Gap

In a recent meeting, a colleague commented on the recent information about the differences in income and consumption among those at the top of the distribution and those at the bottom. The specific observation was that it seemed to indicate that "trickle down doesn't work" or something to that effect. While I didn't respond directly to that comment, I did say something about what isn't spent is usually invested; but not wanting to get into a political discussion, I didn't pursue it. (I generally avoid political discussions because I don't trust politicians of any persuasion. The cynic in me believes that their interest in the position automatically makes them suspect. But that's a subject for another post.)

However, the comment did cause me to continue thinking. As I look at the information, I'm having a hard time seeing where the "trickle down doesn't work" is coming from. From the data, those in the highest income segment spend more than those who don't. What was probably meant was that those at the high end don't spend as great a part of each dollar as those who at the low end. I would agree with that. But I would also point out that because Y = C + S (or income equals consumption plus saving), the funds are still put to use, just differently.

It seems logical that those in higher incomes don't spend all their money on consumption. But it's also fair to believe they don't hide it in a box in the back yard, a mattress, or other non-return generating places. Money is a tool to be used. What is not consumed is usually invested, which provides capital for further production, which one hopes is consumed eventually. The question then becomes "does direct consumption or capital investment have a larger impact in the economy through improved output and productivity, and over how long a period of time?"

This then relates to the marginal propensity to consume of individuals or groups. In other words, do we know or can we predict what any group (I'll avoid individuals) will do with an additional dollar of income. That's where I think the debate inevitably bogs down because factions will promote their view of this marginal propensity: stating or misstating it to their advantage.

One group that feels any stimulus should be directed towards those at the bottom of the income distribution will hold that dollars spent here will have a greater likelihood of being spent on new consumption. This may or may not be true depending upon their existing debt situation and their perceived need to improve that.

Yet another group feels that stimulus should be directed towards those at the upper end of the income distribution because that group already pays the largest share of taxes, and that group will be able to use the funds for new spending. But the upper income group may also choose to reduce their debt position or may choose to invest the windfall, which will not have the immediate effect of consumption. Some of that will depend on how large the stimulus is, I suspect.

While the package has already passed, did you use the stimulus package to discuss marginal propensity to consume, and are you using the recent information on wealth/income/spending gaps to augment the discussion?

I look forward to your comments.